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Fourth Quarter Flareup Risks - Global Exchanges

FICC Podcasts Podcasts October 18, 2022
FICC Podcasts Podcasts October 18, 2022


In this week's episode, we discuss recent developments related to the Japanese yen, the British pound, and the Chinese Renminbi.

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About Global Exchanges

BMO’s FX Strategists, Greg Anderson and Stephen Gallo, offer perspectives from strategy, sales and trading on the foreign exchange market, related financial markets, and the global economy.

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Greg Anderson:                Hi. Welcome to episode 54 of Global Exchanges, a podcast about foreign exchange markets and related issues. In this week's episode, my co-host Stephen Gallo and I discuss recent developments related to the Japanese Yen, the British Pound, and the Chinese Renminbi. The title of this episode is Fourth Quarter Flare-Up Risks.

Stephen Gallo:                  Hi, I'm Stephen Gallo, a London-based FX strategist. Welcome to Global Exchanges, presented by BMO Capital Markets.

Greg Anderson:                Hi, I'm Greg Anderson, a New York based FX strategist. I'm Stephen's co-host.

Stephen Gallo:                  In each weekly podcast like today's, we discuss our perspectives on the global economy and the foreign exchange market. We also bring in guests from the FX industry and from related financial markets like commodities.

Greg Anderson:                We strive to make this show as interactive as possible, so don't hesitate to reach out by going to Thanks for joining us.

Stephen Gallo:                  Okay, it's October 18th, 2022. Thanks for tuning in just a few days after our last podcast listeners. Greg, to open things up, when we were discussing topics for today's podcast, we landed on this issue of a trending dollar market in foreign exchange. It's pretty obvious now. And when we do our simple maths, we see a significant 14% annualized pace of appreciation in the dollar versus the currencies in the BBDXY basket.

                                                And in that context, in past episodes we talked about things breaking in the global financial system. We talked about this happening at spot FX markets and in bond markets as various events have unfolded. Liquidity or the lack of liquidity is becoming a hotter topic in FX markets. So no explanations necessary in that regard.

                                                But Greg, the Japanese Yen and the British Pound definitely remained two of the most interesting currencies year to date and maybe even over a longer timeline. So I want to throw that question over to you. What do you think here?

Greg Anderson:                So compared to that 14% year-to-date benchmark move for the US dollar, the Japanese Yen has indeed moved the most and it has been quite dramatic all year long. The yen is presently down 23% year to date, and is approaching in dollar yen, 150, which is a level that quite frankly, I never would've imagined us reaching a year ago. The pound is presently down only 17% year-to-date, but it also reached a level I never thought I'd see with the dip to 10350 in cable a few weeks ago.

                                                However, I will point out that at the moment the pound has recovered enough to where it now isn't down as much on the year as the New Zealand Dollar, Norwegian Krone and Swedish Krona. Like the yen, these currencies have generally been drifting lower in October, while sterling has mostly held onto its balance above 110.

                                                And I'll point out the pound has also held onto nice little recoveries along most crosses. So Stephen, please walk us through what is behind that.

Stephen Gallo:                  Yeah, that's right Greg. The 110 level in cables held in quite well over the past week, and quite frankly, I think what's happened in my view is that credit risk premium in the UK, they adjusted furiously to the upside, and now those same credit risk premia have moderated a bit as events have unfolded. The risk discount in the pound has mirrored the adjustment in credit markets. It went up, and now the risk discount is back down again. So I think at 113.18, Greg, which is pretty much precisely where we are as we're recording, we're about 10 big figures above the low for the cycle thus far.

Greg Anderson:                It's fascinating that an intervention in the guilt market has helped cure issues in the FX market. But the other factor is the evolution of things in the political sphere. Stephen, how has Liz Truss's withdrawal of her original fiscal package played into this? And where do you see things going over the next month or so?

Stephen Gallo:                  Greg, you know what? You took the words right out of my mouth. I was going to say that we're at a point where the politics in the UK are going to become more dominant drivers of the UK's exchange rate now that we've had the main thrust of economic and financial calamity for Britain. Now, on that note, I would just point out that there are competing views already on this, naturally. Some people, I throw myself in there, think that the storm we saw in UK financial markets was really just act one, while others think it was the final act. My view doesn't necessarily mean I think cable is going to new lows for the cycle. I think we've seen the low for the cycle. I just put myself in the cautious or concerned camp about sterling's prospects against the dollar looking out, say one to three months, and also about the UK's economic fundamentals.

                                                However, on the political side of things, going back to that mess, I think we're partially priced for a resolution and a full rotation of leadership within the conservative party. I say partially priced at 113 and change in cable because the current stalemate I think in the party reflects a lack of direction on the route necessary to have a full rotation. But bottom line, I think full rotation into a Rishi Sunak premiership could be worth maybe two to three more big figures of upside in cable if financial markets remain in their risk on state.

                                                However, I don't want to confuse the picture. I don't think I'm ready to call the 115 to 117 range in cable to new floor yet. I'm more inclined to think it will be a near term ceiling in the pair, if you catch my drift, Greg.

Greg Anderson:                So I guess I get why markets prefer Sunak over Truss just because he's unlikely to be as tone deaf as Truss has seemed to be on economic issues. But look, it's not like he can just snap his fingers and make the UK's current account deficit go away, nor can whoever is the prime minister do much to fix the UK's inflation problem. Right?

Stephen Gallo:                  I think that's right, Greg. There's still a negative flow dynamic for sterling until something changes on that front. So far doesn't look like it. And on economic policy, all that's really happened from a markets perspective is that a window has been broken and then repaired, so to speak. There's been no fundamental change in the overall picture. And at the same time, I'm not convinced that austerity is going to be a viable fiscal option for the UK if that's the route new leadership chooses to go down, not with an energy crisis and not with monetary policy being tight and not with an inflation problem.

                                                And you mentioned inflation specifically Greg, and we'll see what happens with the September consumer price index data tomorrow. But for the time being, it appears as if underlying price pressures are going to remain fairly sticky. And although I said politics will become a more dominant driver of the exchange rate over the next couple weeks or so, I don't think it will necessarily be the only driver.

                                                So for instance, if we get a run of really bad inflation prints for the UK, I can't see how that would be good for sterling, especially if the bond market reacts negatively to this. So bottom line here is that there's still flare up risk out there, although you wouldn't think it if you had a look at cable implied volatility this week, but from a fundamental perspective, yeah, that risk is still there.

                                                Now look, Greg, while cable implied vols are drifting lower here, dollar yen vols are drifting higher. I mean, this is really fascinating when you think about it to have two G7 currencies whose volatility fundamentals are moving in clearly opposing directions to one another. Greg, what does this all mean?

Greg Anderson:                I think it means that markets are a lot more convinced that cable has adjusted enough to die off into a range than dollar yen. Beyond that, honestly, I just don't know where to start on dollar yen. In our last podcast I discussed Japan's September 22nd intervention in detail. I said that I thought the MOF would order more intervention somewhere around 148 and a half if we got there.

                                                Well, as we were recording on Thursday, there was a violent move in dollar yen, and the market consensus view is now that Japan conducted a stealth intervention worth a few billion USD somewhere around 147 and a half. And since then, Japanese officials haven't confirmed that stealth intervention, but they haven't denied it either. Instead, what they've done is they have notified the market about the possibility of them intervening without notification, and without providing details at the end of the month other than just their reserves balances normally reported.

                                                In some ways, that sounds ominous, and it sounds like they will definitely be there defending 150 in dollar yen, which is a level that carries just unbelievable sticker shock in my view. However, the market this week has headed toward 150 since that intervention in a way that just seems like it doesn't care.

Stephen Gallo:                  All right, Greg, so the 100 million yen question, why hasn't the market respected that intervention more fully, Greg?

Greg Anderson:                A hundred million yen question? That's only like $670,000 these days. So I think there must be at least two things going on here. The first is that this introduction of stealth intervention, it's actually a disappointment compared to what the market was looking for. To really turn around the market, Japan needs coordinated intervention with US authorities expressing their commitment to capping dollar yen. And that apparently was not the outcome of whatever conversations that finance Minister Suzuki and Treasure Secretary Janet Yellen had.

                                                If all Yellen was willing to do is to suspend the former agreement that the US Treasury had with the MOF about all interventions being acknowledged promptly and reported in detail, well, that's just not worth all that much.

                                                And I'll point out that this round of meetings of global monitor authorities came and went without even any type of a new agreement to reestablish central bank liquidity lines between the Fed and BOJ, and the Fed and other central banks. I had thought that there was a decent chance of that.

                                                So beyond disappointment on the scale of intervention, the second issue has got to be that we are still dealing with a substantial flow deficit for Japan, and it's showing no signs of going away even though global energy prices have moderated over the past six months and we're at 150 instead of 115.

                                                And so while I view 150 as a level that is super stretched, I can't rule out the dollar yen going higher still. I don't feel ready to drop 160 or even 155 into a base case projection, but I can't rule out either even on a three month horizon.

                                                So Stephen, that brings us to the RMB. Can China's economy withstand further yen depreciation against the RMB?

Stephen Gallo:                  That's a tricky way of framing the issue, Greg. My instant reaction would probably be that Chinese policy makers would prefer the yen didn't weaken sharply, but I also think People's Bank of China and safe are prepared to administer a controlled and orderly depreciation of the RMB from this point forward like they've been doing to date.

                                                Let's see. So a few key macro points here to make. Firstly, China's low inflation economy puts it in its own economic class, so to speak, in the current global environment, and I think that's important. My point is that policy makers are not being forced into an aggressive tightening of policy to strengthen the currency or restrain domestic price pressures. In other words, they're not being led by the Fed. Domestic interest rates are showing no signs of backing up sharply like we've seen in other markets. And not being led by the Fed, I think this fact is as important politically for Xi Jinping as it is for the exchange rate.

                                                So Greg, when it comes to mirroring weakness in other Asian currencies, it's worth emphasizing that China has the ability to smooth moves in its currency like it's been doing due to its external surplus. So any extreme weakness in the currencies of his major trading partners will be mirrored by PBOC in my opinion, because they can't sacrifice that external surplus.

                                                Bottom line, I think there's a clear and orderly path here to our three month target of 727 dollar RMB, unless something we're not expecting on the dollar side of the equation jumps out and surprises us.

                                                I guess the point I'd finish on Greg, sort of tie things up here for the RMB, is that disorderly moves in all Asian currencies at roughly the same time, it can be completely ruled out as a scenario, because if one shoe drops, others might drop and you could see how things could have turned really messy really quickly. Certainly this is not my base case for the RMB and the ADXY, but it's definitely a risk worth considering.

Greg Anderson:                So many risks. There just doesn't seem to be time to discuss them all. And that just seems to be the way things are in the FX market this year.

Stephen Gallo:                  You're too right, Greg, It looks like the flare up risk and volatility will be with us for some time, which gives us a reason to do more podcasts. But let's wrap up episode 54 here. Those of you who stuck with us until the end, again, thanks as always for your time and support. Bye for now.

Greg Anderson:                Thanks for listening to Global Exchanges. Listen to past episodes and find transcripts at

Stephen Gallo:                  We'd love to hear what you thought of today's episode. You can send us an email or reach out to us on Bloomberg. You can listen to this show and subscribe on Apple Podcasts, Spotify, or your favorite podcast provider.

Greg Anderson:                This show and resources are supported by our team here at BMO, including the Thick Macro Strategy Group and BMO's marketing team. This show is produced and edited by Puddle Creative.

Speaker 3:                           The views expressed here are those of the participants and not those of BMO Capital Markets, its affiliates or subsidiaries. For full legal disclosure, visit


Greg Anderson Global Head of FX Strategy
Stephen Gallo European Head of FX Strategy

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